What is a High-Water Mark (HWM)? Guide to Performance Fees

The High-Water Mark (HWM) is a widely used concept in the financial industry, particularly in performance-based investment management. It serves as a benchmark for calculating performance fees and ensuring fairness between fund managers and investors.

The High-Water Mark represents the highest peak in the value of an investment portfolio that has been achieved historically. It is used to determine whether a fund manager is entitled to receive a performance-based fee. Essentially, the principle ensures that managers only earn incentive fees when they generate new profits above the previous highest value.

The High-Water Mark mode (HWM) takes into account previous trading results within a subscription period. In this mode, a performance fee is only earned if the total trading results in the current subscription cover any previous losses and exceed the highest profit previously achieved (the High-Water Mark). Once a new High-Water Mark is reached, it is updated to this higher level.

Why is High-Water Mark(HWM) Important?

The HWM principle protects investors from paying performance fees on recovered losses. Without this mechanism, managers could earn fees even when the fund merely returns to its previous peak after a decline, which would be unfair to investors.

A new High-Water Mark can never be lower than the previous one, and it is always a positive value (starting from an initial value of 0). Performance fees are only paid for positive trading results, meaning providers are compensated only if their trades consistently generate profits for their followers. Losses are acceptable, but providers must first recover any losses before earning a performance fee again. Contrary to some misconceptions, providers are not required to surpass their previous highest result to earn a performance fee; the High-Water Mark is not a historical record but a current threshold.

How Does HWM Work?